fun of funds

Edited by

Kelly DePonteProbitas Partners

Practical intelligence on vital trends and strategies

Third Edition

THE GuiDE ToFunD oF FunDsMAnAGERs

Fund of Funds.indb 1 09/12/2011 17:04:27

Edited by

Kelly DePonteProbitas Partners

Practical intelligence on vital trends and strategies

Third Edition

THE GuiDE ToFunD oF FunDsMAnAGERs


Published in December 2011 byPEisecond Floorsycamore Housesycamore streetLondon EC1Y 0sGunited Kingdom

Telephone: +44 (0)20 7566 5444www.peimedia.com

© 2011 PEI

isBn 978-1-908783-01-1

This publication is not included in the CLA Licence so you must not copy any portion of itwithout the permission of the publisher.

All rights reserved. No parts of this publication may be reproduced, stored in a retrievalsystem or transmitted in any form or by any means including electronic, mechanical,photocopy, recording or otherwise, without written permission of the publisher.

The views and opinions expressed in the book are solely those of the authors and need notreflect those of their employing institutions.

Although every reasonable effort has beenmade to ensure the accuracy of this publication,the publisher accepts no responsibility for any errors or omissions within this publicationor for any expense or other loss alleged to have arisen in any way in connection with areader’s use of this publication.

PEI editor: Helen LewerProduction editor: WilliamWalshe

Printed in the UK by: Hobbs the Printers (www.hobbs.uk.com)


Published in December 2011 byPEisecond Floorsycamore Housesycamore streetLondon EC1Y 0sGunited Kingdom

Telephone: +44 (0)20 7566 5444www.peimedia.com

© 2011 PEI

isBn 978-1-908783-01-1

This publication is not included in the CLA Licence so you must not copy any portion of itwithout the permission of the publisher.

All rights reserved. No parts of this publication may be reproduced, stored in a retrievalsystem or transmitted in any form or by any means including electronic, mechanical,photocopy, recording or otherwise, without written permission of the publisher.

The views and opinions expressed in the book are solely those of the authors and need notreflect those of their employing institutions.

Although every reasonable effort has beenmade to ensure the accuracy of this publication,the publisher accepts no responsibility for any errors or omissions within this publicationor for any expense or other loss alleged to have arisen in any way in connection with areader’s use of this publication.

PEI editor: Helen LewerProduction editor: WilliamWalshe

Printed in the UK by: Hobbs the Printers (www.hobbs.uk.com)


iii

Contents

Figures and tables vii

About the editor ix

Introduction from the editor xi

Section I: In-depth chapters

Funds of funds – a brief history 3By Kelly DePonte, Probitas PartnersDefinition and rationale 3At the creation: separate accounts 4The late 1990s explosion: new funds and new structures 5The last decade 6Summary 10

Why invest via a fund of funds? 13By Stewart Hay, Richard Chapman andAndrzej Plichta, SL Capital Partners LLPWhy invest in funds of funds? 14Where does fund of funds investing fit into the private equityinvestment landscape? 16What is a fund of funds? 17Attractions of a fund of funds 18Why is the cash-flow profile of a fund of funds important? 19What should investors look for in a private equity fund of funds manager? 20

Private equity fund of funds investment strategy 23By Hanneke Smits and Kathy Wanner, Adams Street PartnersIntroduction 23Investment strategy and process 23Organisational stability 30Conclusion 30

Legal issues on structuring a private equity fund of funds 33By SolomonWifa, O’Melveny & Myers LLPIntroduction 33

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iii

Contents

Figures and tables vii

About the editor ix

Introduction from the editor xi

Section I: In-depth chapters

Funds of funds – a brief history 3By Kelly DePonte, Probitas PartnersDefinition and rationale 3At the creation: separate accounts 4The late 1990s explosion: new funds and new structures 5The last decade 6Summary 10

Why invest via a fund of funds? 13By Stewart Hay, Richard Chapman andAndrzej Plichta, SL Capital Partners LLPWhy invest in funds of funds? 14Where does fund of funds investing fit into the private equityinvestment landscape? 16What is a fund of funds? 17Attractions of a fund of funds 18Why is the cash-flow profile of a fund of funds important? 19What should investors look for in a private equity fund of funds manager? 20

Private equity fund of funds investment strategy 23By Hanneke Smits and Kathy Wanner, Adams Street PartnersIntroduction 23Investment strategy and process 23Organisational stability 30Conclusion 30

Legal issues on structuring a private equity fund of funds 33By SolomonWifa, O’Melveny & Myers LLPIntroduction 33

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iv

Contents

Considerations that influence the choice of a fund of funds structure 33Common fund of funds structures 34Regulatory issues 38Principal terms and conditions 40Common US tax and regulatory issues 41

The growing importance of new and next generationmanagers in private equity 47By Kelvin Liu, Invesco Private CapitalIntroduction 47Historical strategy of PE investing 47Transformation of the PE industry demands new approach 48Seeking alpha through new and next generation managers 51The art of selecting new and next generation managers 52Conclusion 52

Private equity separate account investment vehicles 55By Kelly DePonte, Probitas PartnersIntroduction 55Evolution of outsourced investing 56The return of separate accounts 57Focused separate accounts versus allocated separate accounts 59Key issues for investors 60Summary 60

Co-investments in funds of funds and separate accounts 63By Brian Gallagher, Twin Bridge Capital PartnersBackground 63History of the co-investment process 63Current state of co-investment 63Benefits to the LP 64Benefits to the equity sponsor 65The co-investment process 65Sourcing 66Myths about co-investing 68Success factors in co-investing 69The future of co-investing 69

Regional focus: developments in Asian emerging markets 71By Veronica John and E. Brooke Whitaker, Serasi CapitalCurrent global trends pose challenges for funds of funds, but not in Asia 71Asia – investors must allocate 72Asia-focused fund of funds landscape 73Why do investors prefer the fund of funds route to going direct in Asia? 75Similarities and differences between Asia-focused funds of funds andthe rest of the industry 76Understanding the different private equity models deployed 77

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iv

Contents

Considerations that influence the choice of a fund of funds structure 33Common fund of funds structures 34Regulatory issues 38Principal terms and conditions 40Common US tax and regulatory issues 41

The growing importance of new and next generationmanagers in private equity 47By Kelvin Liu, Invesco Private CapitalIntroduction 47Historical strategy of PE investing 47Transformation of the PE industry demands new approach 48Seeking alpha through new and next generation managers 51The art of selecting new and next generation managers 52Conclusion 52

Private equity separate account investment vehicles 55By Kelly DePonte, Probitas PartnersIntroduction 55Evolution of outsourced investing 56The return of separate accounts 57Focused separate accounts versus allocated separate accounts 59Key issues for investors 60Summary 60

Co-investments in funds of funds and separate accounts 63By Brian Gallagher, Twin Bridge Capital PartnersBackground 63History of the co-investment process 63Current state of co-investment 63Benefits to the LP 64Benefits to the equity sponsor 65The co-investment process 65Sourcing 66Myths about co-investing 68Success factors in co-investing 69The future of co-investing 69

Regional focus: developments in Asian emerging markets 71By Veronica John and E. Brooke Whitaker, Serasi CapitalCurrent global trends pose challenges for funds of funds, but not in Asia 71Asia – investors must allocate 72Asia-focused fund of funds landscape 73Why do investors prefer the fund of funds route to going direct in Asia? 75Similarities and differences between Asia-focused funds of funds andthe rest of the industry 76Understanding the different private equity models deployed 77

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v

Contents

What are the prospects for Asian Funds? 78Conclusion 79

Section II: From the Private Equity International archive

Private Equity International coverage on funds of funds 83Standing out from the crowd 83Don’t be a JAFOF 87Survival of the fittest 89Same rules, different concerns 92Private equity is going bespoke 95Albert: LPs will flock to established FoFs 98News analysis: The FoF phenomenon 100

Section III: The survey

Current trends in the fund of funds market: A surveyof practitioners 105

Profile of respondents 105Sectors and geographies of interest 108Secondaries and co-investments 114Terms and conditions 114Greatest fears 115Summary 116

Section IV: The directory

A comprehensive directory of fund of funds practitionersand advisers 121

About PEI 216


v

Contents

What are the prospects for Asian Funds? 78Conclusion 79

Section II: From the Private Equity International archive

Private Equity International coverage on funds of funds 83Standing out from the crowd 83Don’t be a JAFOF 87Survival of the fittest 89Same rules, different concerns 92Private equity is going bespoke 95Albert: LPs will flock to established FoFs 98News analysis: The FoF phenomenon 100

Section III: The survey

Current trends in the fund of funds market: A surveyof practitioners 105

Profile of respondents 105Sectors and geographies of interest 108Secondaries and co-investments 114Terms and conditions 114Greatest fears 115Summary 116

Section IV: The directory

A comprehensive directory of fund of funds practitionersand advisers 121

About PEI 216


vii

Figures and tables

Figure 1.1: Global commitments to funds of funds 5

Figure 2.1: Pooled IRR for European buyouts, as at December 31, 2010 14

Figure 2.2: Structure of a fund of funds 18

Figure 2.3: Example cash-flow of a fund of funds 19

Figure 3.1: Market assessment methodology 26

Figure 3.2: Subclass assessment by market 27

Figure 5.1: US venture capital industry – assets under management 48

Figure 5.2: US buyout & mezzanine industry – assets under management 49

Figure 5.3: Average debt/EBITDA – large-cap US leveraged buyouts 49

Figure 6.1: Global private equity raised per annum (1991–2011) 56

Figure 7.1: Sample net cash-flow by year – traditional funds of funds versusfund of funds with co-investment 64

Figure 7.2: The co-investment process 66

Figure 1: Location of firms’ headquarters 106

Figure 2: Number of years active in private equity investing 106

Figure 3: Strategies offered by funds of funds 107

Figure 4: Targeted amount of private equity allocations across all fundsfor 2012 (in US Dollars) 107

Figure 5: Target sectors for investment for 2012 108

Survey figures

Figures


vii

Figures and tables

Figure 1.1: Global commitments to funds of funds 5

Figure 2.1: Pooled IRR for European buyouts, as at December 31, 2010 14

Figure 2.2: Structure of a fund of funds 18

Figure 2.3: Example cash-flow of a fund of funds 19

Figure 3.1: Market assessment methodology 26

Figure 3.2: Subclass assessment by market 27

Figure 5.1: US venture capital industry – assets under management 48

Figure 5.2: US buyout & mezzanine industry – assets under management 49

Figure 5.3: Average debt/EBITDA – large-cap US leveraged buyouts 49

Figure 6.1: Global private equity raised per annum (1991–2011) 56

Figure 7.1: Sample net cash-flow by year – traditional funds of funds versusfund of funds with co-investment 64

Figure 7.2: The co-investment process 66

Figure 1: Location of firms’ headquarters 106

Figure 2: Number of years active in private equity investing 106

Figure 3: Strategies offered by funds of funds 107

Figure 4: Targeted amount of private equity allocations across all fundsfor 2012 (in US Dollars) 107

Figure 5: Target sectors for investment for 2012 108

Survey figures

Figures


viii

Figures and tables

Figure 6: Target sectors for investment in 2012 –North American respondents only 109

Figure 7: Most attractive geographical focus for 2012 110

Figure 8: Most attractive European investment regions forEuropean-focused funds 110

Figure 9: Most attractive markets in Asia 111

Figure 10: Most attractive strategies/sectors in the US mid-market 111

Figure 11: Most attractive sectors/stages in venture capital 112

Figure 12: Most attractive emerging markets 113

Figure 13: Approach to secondary markets 113

Figure 14: Directs and co-investments activity 114

Figure 15: Attitude to the ILPA Private Equity Principles 115

Figure 16: The most important issues regarding terms/structures of a fund 115

Figure 17: Fund of funds managers’ greatest fears about the currentprivate equity market 116

Table 1.1: Ten largest private fund of funds vehicles, 2011 7

Table 1.2: The five largest publicly traded fund of funds vehicles, 2011 8

Table 1.3: Private equity and funds of funds: a timeline 10

Tables


viii

Figures and tables

Figure 6: Target sectors for investment in 2012 –North American respondents only 109

Figure 7: Most attractive geographical focus for 2012 110

Figure 8: Most attractive European investment regions forEuropean-focused funds 110

Figure 9: Most attractive markets in Asia 111

Figure 10: Most attractive strategies/sectors in the US mid-market 111

Figure 11: Most attractive sectors/stages in venture capital 112

Figure 12: Most attractive emerging markets 113

Figure 13: Approach to secondary markets 113

Figure 14: Directs and co-investments activity 114

Figure 15: Attitude to the ILPA Private Equity Principles 115

Figure 16: The most important issues regarding terms/structures of a fund 115

Figure 17: Fund of funds managers’ greatest fears about the currentprivate equity market 116

Table 1.1: Ten largest private fund of funds vehicles, 2011 7

Table 1.2: The five largest publicly traded fund of funds vehicles, 2011 8

Table 1.3: Private equity and funds of funds: a timeline 10

Tables


ix

About the editor

Kelly DePonte is the head of research and due diligence at Probitas Partners, a leadingglobal provider of integrated, alternative investment solutions including fund placementand portfolio management services. Kelly is based in the firm’s San Francisco office andhas over 30 years experience in the industry. Before joining Probitas Partners, Kelly waschief operating officer and a managing director at Pacific Corporate Group, a privateequity consultancy firm, where he also directed the partnership investment programme.Before that he spent several years with First Interstate Bank where he most recentlyoversaw its private equity activity and interest rate swap activity. Kelly is also amember ofthe Editorial Advisory Board of PEI’s quarterly journal The Review of Private Equity. Kellyreceived an MBA from UCLA and a BA in Communications from Stanford University.


ix

About the editor

Kelly DePonte is the head of research and due diligence at Probitas Partners, a leadingglobal provider of integrated, alternative investment solutions including fund placementand portfolio management services. Kelly is based in the firm’s San Francisco office andhas over 30 years experience in the industry. Before joining Probitas Partners, Kelly waschief operating officer and a managing director at Pacific Corporate Group, a privateequity consultancy firm, where he also directed the partnership investment programme.Before that he spent several years with First Interstate Bank where he most recentlyoversaw its private equity activity and interest rate swap activity. Kelly is also amember ofthe Editorial Advisory Board of PEI’s quarterly journal The Review of Private Equity. Kellyreceived an MBA from UCLA and a BA in Communications from Stanford University.


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Introduction from the editor

When the second edition of A Guide to Private Equity Fund of Funds Managers waspublished in early 2008 we were unknowingly at the beginning of the Great FinancialCrisis (GFC). That crisis dramatically affected the private equity industry and the fund offundsmarket as well. It accelerated changes that have led to an increased set of targetedproduct offerings and separate account vehicles taking their place alongside the well-established globally diversified funds that originally started out in the market.

While the fundamentals of funds of funds have not radically changed, the markethas become more complex and in the coming months the industry will also have tocomprehend the raft of regulatory changes emanating from Europe and the US, andassess the impact it might have. The new market dynamics are reflected in this thirdedition of the guide, which includes an entirely new chapter on the growing importanceof new and next generation managers in addition to a number of fully revised andupdated chapters from the previous edition. It also includes a new survey of fund offunds managers, which analyses current trends in the market and highlights the marketsegments, investment strategies and geographic areas that are of most interest topractitioners as well as the challenges they face in doing their business. There is also acomprehensive directory containing the profiles of over 190 fund of funds managers.

Wehavebeen fortunate toattract agroupof distinguished industrypractitioners toauthorthe chapters of this book. Most of the material here has been written by individuals whohave devoted their spare time, in spite of busy professional schedules, to share theirknowledge of the market. This book would not be possible without their contributionsand the editors wish to express their profound thanks to all the authors.

Kelly DePonte


xi

Introduction from the editor

When the second edition of A Guide to Private Equity Fund of Funds Managers waspublished in early 2008 we were unknowingly at the beginning of the Great FinancialCrisis (GFC). That crisis dramatically affected the private equity industry and the fund offundsmarket as well. It accelerated changes that have led to an increased set of targetedproduct offerings and separate account vehicles taking their place alongside the well-established globally diversified funds that originally started out in the market.

While the fundamentals of funds of funds have not radically changed, the markethas become more complex and in the coming months the industry will also have tocomprehend the raft of regulatory changes emanating from Europe and the US, andassess the impact it might have. The new market dynamics are reflected in this thirdedition of the guide, which includes an entirely new chapter on the growing importanceof new and next generation managers in addition to a number of fully revised andupdated chapters from the previous edition. It also includes a new survey of fund offunds managers, which analyses current trends in the market and highlights the marketsegments, investment strategies and geographic areas that are of most interest topractitioners as well as the challenges they face in doing their business. There is also acomprehensive directory containing the profiles of over 190 fund of funds managers.

Wehavebeen fortunate toattract agroupof distinguished industrypractitioners toauthorthe chapters of this book. Most of the material here has been written by individuals whohave devoted their spare time, in spite of busy professional schedules, to share theirknowledge of the market. This book would not be possible without their contributionsand the editors wish to express their profound thanks to all the authors.

Kelly DePonte


3

1 Funds of funds – a brief history

By Kelly DePonte, Probitas Partners

Funds of funds are such a fixture on the current private equity landscape that it is difficultto remember they are a fairly recent phenomenon. Though institutional private equityvehicles trace their roots back to the 1940s (see the timeline in Table 1.3), the privateequity market remained too shallow to support funds of funds vehicles until the 1970s.Large investment vehicles are creatures of the last 12 years, and this period of growthhas seen a tremendous amount of change and a proliferation of strategies to deal withthat change.

Even with an investment product as ubiquitous as a fund of funds, it is useful to go back tofirst principles and define exactly what is meant by a fund of funds vehicle. According toVCExperts.com, a fund of funds is:

“A fund set up to distribute investments among a selection of private equity fundmanagers, who in turn invest the capital directly. Fund of funds are specialist privateequity investors and have existing relationships with firms. They may be able to provideinvestors with a route to investing in particular funds that would otherwise be closedto them. Investing in funds of funds can also help spread the risk of investing in privateequity because they invest the capital in a variety of funds.”1

The key reasons investors look to funds of funds are embedded in that definition:

Specialist expertise.• The due diligence process for investing in private equity funds isboth complex and arcane. (Private Equity International publishes a book entitled TheGuide to Private Equity Fund Investment Due Diligence, which details the complexitiesof fundmanager selection.) Successful fund of fundsmanagers have developed provenexpertise in fund selection – expertise that is difficult for smaller investors or newmarketentrants to replicate quickly.Access.• Successful fund of funds managers have relationships with primary managerswho have been successful in the past, and who may be difficult for new investors toaccess, especially in the venture capital market.Diversification.• Given thatmany private equity funds haveminimumcommitments of $5million to $25million, it is often difficult for small investors to build diversified portfoliosthat offer protection in what is a volatile asset class. The vast majority of funds of fundsare multi-manager vehicles that offer smaller investors managed diversification.

1 VCExperts.com at: http://vcexperts.com/encyclopedia/glossary/227

Definition andrationale


3

1 Funds of funds – a brief history

By Kelly DePonte, Probitas Partners

Funds of funds are such a fixture on the current private equity landscape that it is difficultto remember they are a fairly recent phenomenon. Though institutional private equityvehicles trace their roots back to the 1940s (see the timeline in Table 1.3), the privateequity market remained too shallow to support funds of funds vehicles until the 1970s.Large investment vehicles are creatures of the last 12 years, and this period of growthhas seen a tremendous amount of change and a proliferation of strategies to deal withthat change.

Even with an investment product as ubiquitous as a fund of funds, it is useful to go back tofirst principles and define exactly what is meant by a fund of funds vehicle. According toVCExperts.com, a fund of funds is:

“A fund set up to distribute investments among a selection of private equity fundmanagers, who in turn invest the capital directly. Fund of funds are specialist privateequity investors and have existing relationships with firms. They may be able to provideinvestors with a route to investing in particular funds that would otherwise be closedto them. Investing in funds of funds can also help spread the risk of investing in privateequity because they invest the capital in a variety of funds.”1

The key reasons investors look to funds of funds are embedded in that definition:

Specialist expertise.• The due diligence process for investing in private equity funds isboth complex and arcane. (Private Equity International publishes a book entitled TheGuide to Private Equity Fund Investment Due Diligence, which details the complexitiesof fundmanager selection.) Successful fund of fundsmanagers have developed provenexpertise in fund selection – expertise that is difficult for smaller investors or newmarketentrants to replicate quickly.Access.• Successful fund of funds managers have relationships with primary managerswho have been successful in the past, and who may be difficult for new investors toaccess, especially in the venture capital market.Diversification.• Given thatmany private equity funds haveminimumcommitments of $5million to $25million, it is often difficult for small investors to build diversified portfoliosthat offer protection in what is a volatile asset class. The vast majority of funds of fundsare multi-manager vehicles that offer smaller investors managed diversification.

1 VCExperts.com at: http://vcexperts.com/encyclopedia/glossary/227

Definition andrationale


4

section i: in-depth chapters

The first fund of funds was formed in the 1970s as the number of primary fund offeringsincreased, and fund selection becamemore of an issue. However, the fund of fundsmarketas a whole did not become significant until the 1990s when the primarymarket significantlyexpanded (see Figure 1.1). What is more difficult to track, however, are separate accounts.Commitments to separate accounts are not consistently included in these numbers, andseparate accounts themselves were more prevalent early on in the market.

A separate account is an agreement between a professional third-party manager and aninstitutional investor crafted to a specific investment mandate. It can be documented bya simple contract between the parties for a fixed duration, or it can take the form of a fullystructured fund of funds vehicle that has a single investor. Even when structured as a formalfund of funds, there is little information publicly available on separate accounts as they areagreements only between the two parties and generally include confidentiality provisions.

Many of the first fund of funds providers, including Adams Street (previously Brinson) andHarbourVest, actively provided separate accounts to large institutional investors early intheir careers. For these large investors, separate accounts were a way to tap into third-partyexpertise and leverage internal staff at a point where private equity was just beginning todevelop as a market – experienced professionals with a background in fund due diligencewere very rare. For the separate account providers, relationships with large institutionalinvestors allowed them to quickly increase assets under management, even though thefees on separate accounts were usually lower than those on a multi-party fund of fundsbecause of the pricing power that large investors commanded. It was just this pricingdynamic – combined with an increase in private equity investments by a number of newmarket entrants – that led to a decline in the use of separate accounts and the beginningsof an increase both in the number of funds of funds and the amount of money committedto them in the early 1990s.

This was growth from an admittedly small base – it wasn’t until 1995 that more than a billiondollars was raised for funds of funds in a single year, and it wasn’t until 1997 that more than$5 billion was raised.

The expansion of multi-investor funds of funds provided several advantages to fundmanagers:

Pricing• . With multi-investor funds of funds, negotiating power shifted from the investorto the fund manager. The wholesale discounts available to large investors were notusually available on multi-investor funds.Assetsundermanagement• .Bytappingintoanumberofsmaller investorssimultaneously,fundmanagerswere able to buildmore quickly their base of assets undermanagement.When combined with the better pricing margin, this led to increased profitability.Efficiency• . For a fund of funds manager, managing a large pool of money with a singleinvestment mandate is more efficient than managing multiple, uniquely designedseparate accounts at the same time. With a single global mandate, a fund of fundsmanager can deploy more capital into fewer funds, minimising time spent on duediligence, making larger commitments with each individual underlying fund anddeveloping stronger relationships with general partners (GP) during the process.

At the creation:separateaccounts


4


The first fund of funds was formed in the 1970s as the number of primary fund offeringsincreased, and fund selection becamemore of an issue. However, the fund of fundsmarketas a whole did not become significant until the 1990s when the primarymarket significantlyexpanded (see Figure 1.1). What is more difficult to track, however, are separate accounts.Commitments to separate accounts are not consistently included in these numbers, andseparate accounts themselves were more prevalent early on in the market.

A separate account is an agreement between a professional third-party manager and aninstitutional investor crafted to a specific investment mandate. It can be documented bya simple contract between the parties for a fixed duration, or it can take the form of a fullystructured fund of funds vehicle that has a single investor. Even when structured as a formalfund of funds, there is little information publicly available on separate accounts as they areagreements only between the two parties and generally include confidentiality provisions.

Many of the first fund of funds providers, including Adams Street (previously Brinson) andHarbourVest, actively provided separate accounts to large institutional investors early intheir careers. For these large investors, separate accounts were a way to tap into third-partyexpertise and leverage internal staff at a point where private equity was just beginning todevelop as a market – experienced professionals with a background in fund due diligencewere very rare. For the separate account providers, relationships with large institutionalinvestors allowed them to quickly increase assets under management, even though thefees on separate accounts were usually lower than those on a multi-party fund of fundsbecause of the pricing power that large investors commanded. It was just this pricingdynamic – combined with an increase in private equity investments by a number of newmarket entrants – that led to a decline in the use of separate accounts and the beginningsof an increase both in the number of funds of funds and the amount of money committedto them in the early 1990s.

This was growth from an admittedly small base – it wasn’t until 1995 that more than a billiondollars was raised for funds of funds in a single year, and it wasn’t until 1997 that more than$5 billion was raised.

The expansion of multi-investor funds of funds provided several advantages to fundmanagers:

Pricing• . With multi-investor funds of funds, negotiating power shifted from the investorto the fund manager. The wholesale discounts available to large investors were notusually available on multi-investor funds.Assetsundermanagement• .Bytappingintoanumberofsmaller investorssimultaneously,fundmanagerswere able to buildmore quickly their base of assets undermanagement.When combined with the better pricing margin, this led to increased profitability.Efficiency• . For a fund of funds manager, managing a large pool of money with a singleinvestment mandate is more efficient than managing multiple, uniquely designedseparate accounts at the same time. With a single global mandate, a fund of fundsmanager can deploy more capital into fewer funds, minimising time spent on duediligence, making larger commitments with each individual underlying fund anddeveloping stronger relationships with general partners (GP) during the process.

At the creation:separateaccounts


13

2 Why invest via a fund of funds?

By Stewart Hay, Richard Chapman and Andrzej Plichta,SL Capital Partners LLP

For an investor seeking diversification across a variety of asset classes, private equitymay only represent 2 to 5 percent of an investment portfolio. However, with returns fromprivate equity potentially in the 13 to 18 percent range1, this asset class has the potential torepresent a significant portion of the outperformance of an overall investment portfolio.

Typical investors include pension schemes, sovereign wealth funds, foundations andendowments, financial institutions, family offices and high net worth individuals. In the US,where acceptance of the asset class is greater, some investors, generally foundations andendowments, now have exposure levels to alternative assets that account for a significantportion of their portfolios. For example, theWashington State Investment Board (that is thepension scheme for the state of Washington) in the US specifically targets private equity as25 percent of their portfolio while the average allocation to private equity of pension plansstands at 5.5 percent.2

As you might expect though, it is not quite as straightforward as simply making anallocation to the asset class then sitting back and making high returns. There is a muchwider dispersion of returns between the best managers and average managers in privateequity than is seen in other asset classes.3

Data from Thomson ONE is very instructive in this regard. Figure 2.1 shows returninformation for European buyout managers over various time periods. Focusing on theten-year internal rates of return, we see that the median return over this period was 9.1percent, while the top-quartile break point was 19.4 percent, an outperformance of 10.3percent over the median, illustrating the crucial importance of selecting top-quartilemanagers. This point is highlighted even more by the bottom-quartile benchmark of -14.4percent over the same ten-year horizon, a huge 23.5 percent below the median (returnnumbers in the US market are similar to these).

These statistics drive home the point that unlike the situation in publicly traded securities,where sector allocation can drive returns, manager selection is absolutely critical to thesuccess of any private equity investment strategy.

1 Thomson ONE state that the pooled average ten year buyout return for top-quartile funds in Europe is19.4 percent. A fund of funds would expect to be able to use its expertise to exceed the pooled median IRRfor all funds in this category of 9.1 percent.2 Preqin, (February 2011), Public Pension Plans and Alternative Assets.3 Thomson ONE (to December 31, 2010, sourced October 31, 2011).


13

2 Why invest via a fund of funds?

By Stewart Hay, Richard Chapman and Andrzej Plichta,SL Capital Partners LLP

For an investor seeking diversification across a variety of asset classes, private equitymay only represent 2 to 5 percent of an investment portfolio. However, with returns fromprivate equity potentially in the 13 to 18 percent range1, this asset class has the potential torepresent a significant portion of the outperformance of an overall investment portfolio.

Typical investors include pension schemes, sovereign wealth funds, foundations andendowments, financial institutions, family offices and high net worth individuals. In the US,where acceptance of the asset class is greater, some investors, generally foundations andendowments, now have exposure levels to alternative assets that account for a significantportion of their portfolios. For example, theWashington State Investment Board (that is thepension scheme for the state of Washington) in the US specifically targets private equity as25 percent of their portfolio while the average allocation to private equity of pension plansstands at 5.5 percent.2

As you might expect though, it is not quite as straightforward as simply making anallocation to the asset class then sitting back and making high returns. There is a muchwider dispersion of returns between the best managers and average managers in privateequity than is seen in other asset classes.3

Data from Thomson ONE is very instructive in this regard. Figure 2.1 shows returninformation for European buyout managers over various time periods. Focusing on theten-year internal rates of return, we see that the median return over this period was 9.1percent, while the top-quartile break point was 19.4 percent, an outperformance of 10.3percent over the median, illustrating the crucial importance of selecting top-quartilemanagers. This point is highlighted even more by the bottom-quartile benchmark of -14.4percent over the same ten-year horizon, a huge 23.5 percent below the median (returnnumbers in the US market are similar to these).

These statistics drive home the point that unlike the situation in publicly traded securities,where sector allocation can drive returns, manager selection is absolutely critical to thesuccess of any private equity investment strategy.

1 Thomson ONE state that the pooled average ten year buyout return for top-quartile funds in Europe is19.4 percent. A fund of funds would expect to be able to use its expertise to exceed the pooled median IRRfor all funds in this category of 9.1 percent.2 Preqin, (February 2011), Public Pension Plans and Alternative Assets.3 Thomson ONE (to December 31, 2010, sourced October 31, 2011).


14


An additional attraction that private equity can offer besides the potential for highreturns is the significant diversification benefits.4 A number of studies have shown thathistorically long-term private equity returns have not been correlated closely with returnsfrom traditional asset classes. This means private equity can help to smooth out the returnof a balanced portfolio. Furthermore, it provides greater access to the real economythan the stock markets where diversification is often limited to larger firms in the moreestablished industries.

When choosing to invest directly into private equity deals or funds there are many diversecapabilities and resources required in order to be able to successfully participate. A few ofthese are summarised below.

The skills required to invest in private equity are significantly different from thoseneeded to invest in the listed markets. The lack of a public marketplace meanspurchases must be privately negotiated with the seller of the company. As the companyis privately held, there is generally limited information available from resources suchas the internet, Reuters and Bloomberg. As such, the only way to find out informationabout private companies is to go out and visit them, review all available internal andexternal information and meet with the management of that company. Investingin private equity is certainly not something that can be done sitting behind a desk.

As a result, to make such an informed decision and generate the highest returns, theprocess of investing in private equity is far more labour-intensive than investing in listed

4 Faulds, Graeme, (2002), An Exploration of the Issues Involved in Making an Allocation to Private Equity.

Why invest infunds of funds?

Skills

5 years 10 years 15 years

-20

0

30

-10

20

10

40

Source: Thomson ONE, as at December 31, 2010 (sourced at October 3, 2011).

Figure 2.1: Pooled iRR for European buyouts, as at December 31, 2010

Top quartile

All buyouts

Bottom quartile

PooledIRR(%

)


14


An additional attraction that private equity can offer besides the potential for highreturns is the significant diversification benefits.4 A number of studies have shown thathistorically long-term private equity returns have not been correlated closely with returnsfrom traditional asset classes. This means private equity can help to smooth out the returnof a balanced portfolio. Furthermore, it provides greater access to the real economythan the stock markets where diversification is often limited to larger firms in the moreestablished industries.

When choosing to invest directly into private equity deals or funds there are many diversecapabilities and resources required in order to be able to successfully participate. A few ofthese are summarised below.

The skills required to invest in private equity are significantly different from thoseneeded to invest in the listed markets. The lack of a public marketplace meanspurchases must be privately negotiated with the seller of the company. As the companyis privately held, there is generally limited information available from resources suchas the internet, Reuters and Bloomberg. As such, the only way to find out informationabout private companies is to go out and visit them, review all available internal andexternal information and meet with the management of that company. Investingin private equity is certainly not something that can be done sitting behind a desk.

As a result, to make such an informed decision and generate the highest returns, theprocess of investing in private equity is far more labour-intensive than investing in listed

4 Faulds, Graeme, (2002), An Exploration of the Issues Involved in Making an Allocation to Private Equity.

Why invest infunds of funds?

Skills

5 years 10 years 15 years

-20

0

30

-10

20

10

40

Source: Thomson ONE, as at December 31, 2010 (sourced at October 3, 2011).

Figure 2.1: Pooled iRR for European buyouts, as at December 31, 2010

Top quartile

All buyouts

Bottom quartile

PooledIRR(%

)


47

5 The growing importance of new and nextgeneration managers in private equityBy Kelvin Liu, Invesco Private Capital

Over the last decade, there has been growing interest among institutional investorsin committing to private equity funds managed by new and next generation (N&NG)managers where fund managers are raising their first, second or third institutionalquality fund. Large public institutions, such as California Public Employees’ RetirementSystem (CalPERS) and California State Teachers’ Retirement System (CalSTRS), have setup and continue to support programmes dedicated to identifying these rising stars ofthe future. This exemplifies the perspective of some of the most sophisticated investorsthat the traditional way of investing only in proven managers may not be adequate.Without continual rejuvenation of their private equity (PE) programme, institutionalinvestors may miss capturing the most promising private equity returns going forward.Consequently, many institutional investors increasingly believe that building a coreportfolio of premier established names and supplementing it with a group of promisingN&NG managers is likely to be an effective portfolio construction strategy, addingdiversification and opportunistic elements with the potential to strengthen risk-adjustedreturns over the long run.

However, the organisational structure of many financial institutions, both large and small,may constrain their ability to address these opportunities effectively. Large institutionsoften find it difficult to commit the necessary resources to consider smaller commitments,maintain the enhanced monitoring required and conduct the specialised diligence toidentify the truly deserving N&NG managers. On the other hand, smaller institutionslack both the internal resources and the capital needed to achieve a well-diversifiedprogramme to mitigate risk. This is where funds of funds and separate account managersare able to play an important role in helping institutional investors achieve their returnobjectives by providing dedicated resources and expertise to create a well-diversifiedportfolio of promising N&NG managers. Indeed, over the last decade, several funds offunds and separate account managers have offered specialised products to address thismarket specifically.

Historically, institutional investors often sought solace through investing with brandname PE managers that could tout top-quartile track records. Investors would continueto back them, fund after fund, or risk losing access to their later funds. Agency Theorymight have played a role in this Buy-IBMmentality. This strategy might have worked wellfor some investors in the early and mid-1990s when the universe of PE managers wassmall and there were only a handful of firms with proven track records. However, whilewe agree that some high-quality fund managers have developed a set of distinctive

Introduction

Historicalstrategy of PE

investing


47

5 The growing importance of new and nextgeneration managers in private equityBy Kelvin Liu, Invesco Private Capital

Over the last decade, there has been growing interest among institutional investorsin committing to private equity funds managed by new and next generation (N&NG)managers where fund managers are raising their first, second or third institutionalquality fund. Large public institutions, such as California Public Employees’ RetirementSystem (CalPERS) and California State Teachers’ Retirement System (CalSTRS), have setup and continue to support programmes dedicated to identifying these rising stars ofthe future. This exemplifies the perspective of some of the most sophisticated investorsthat the traditional way of investing only in proven managers may not be adequate.Without continual rejuvenation of their private equity (PE) programme, institutionalinvestors may miss capturing the most promising private equity returns going forward.Consequently, many institutional investors increasingly believe that building a coreportfolio of premier established names and supplementing it with a group of promisingN&NG managers is likely to be an effective portfolio construction strategy, addingdiversification and opportunistic elements with the potential to strengthen risk-adjustedreturns over the long run.

However, the organisational structure of many financial institutions, both large and small,may constrain their ability to address these opportunities effectively. Large institutionsoften find it difficult to commit the necessary resources to consider smaller commitments,maintain the enhanced monitoring required and conduct the specialised diligence toidentify the truly deserving N&NG managers. On the other hand, smaller institutionslack both the internal resources and the capital needed to achieve a well-diversifiedprogramme to mitigate risk. This is where funds of funds and separate account managersare able to play an important role in helping institutional investors achieve their returnobjectives by providing dedicated resources and expertise to create a well-diversifiedportfolio of promising N&NG managers. Indeed, over the last decade, several funds offunds and separate account managers have offered specialised products to address thismarket specifically.

Historically, institutional investors often sought solace through investing with brandname PE managers that could tout top-quartile track records. Investors would continueto back them, fund after fund, or risk losing access to their later funds. Agency Theorymight have played a role in this Buy-IBMmentality. This strategy might have worked wellfor some investors in the early and mid-1990s when the universe of PE managers wassmall and there were only a handful of firms with proven track records. However, whilewe agree that some high-quality fund managers have developed a set of distinctive

Introduction

Historicalstrategy of PE

investing


48


capabilities1 and reputations, the general application of this rule may not be effective incapturing the best PE returns going forward, especially given the changes and gradualmaturing of the PE industry over the last decade.

The static strategy of solely backing brand name funds may no longer fully capture thestrongest risk-adjusted returns due to the transformation of the industry that has taken placeover the last decade.Venture capital saw its assets undermanagement (AUM) growover four-fold from under $45 billion in 1996 to $187 billion by 2006.2With such rapid capital injection,individual venture funds grew larger in size and raised capital at a faster pace, while manyexpanded into strategies in which they had little or no domain expertise.

The buyout industry has also experienced explosive growth. The industry’s AUMincreased by a similar magnitude from $113 billion in 1996 to over $600 billion in2006.3 In fact, the rapid growth of the industry did not abate until the onset of the2008 credit crisis. With cheap and readily available credit, buyout funds not onlygrew larger in size, they also leveraged their portfolio companies to unprecedentedlevels. The average debt-to-EBITDA (earnings before interest, taxes, depreciation andamortisation) ratio peaked at 6.2x in 2007.4 This growth in leverage was reversed twice

1 BCG & IESE Business School. (February 2008). The Advantage of Persistence.2 Thomson Reuters. Invested vs. Uninvested Capital and Cash-Flow Summary Reports, venture only, as atDecember 31, 2010.3 Thomson Reuters. Invested vs. Uninvested Capital and Cash-Flow Summary Reports, buyouts and otherprivate equity only, as at December 31, 2010.4 S&P Leverage Lending Review 4 Q10. (2010). Large-Cap buyouts are companies with EBITDA >$50m.

Transformationof the PEindustry

demands newapproach

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2006

2002

2007

2003

2008

2004

2009

2005

2010

Years

$billion

0

50

200

150

100

Source: Thomson Reuters. Invested vs. Uninvested Capital and Cash-Flow Summary Reports, ventureonly, as of December 31, 2010.

Figure 5.1: us venture capital industry – assets under management


48


capabilities1 and reputations, the general application of this rule may not be effective incapturing the best PE returns going forward, especially given the changes and gradualmaturing of the PE industry over the last decade.

The static strategy of solely backing brand name funds may no longer fully capture thestrongest risk-adjusted returns due to the transformation of the industry that has taken placeover the last decade.Venture capital saw its assets undermanagement (AUM) growover four-fold from under $45 billion in 1996 to $187 billion by 2006.2With such rapid capital injection,individual venture funds grew larger in size and raised capital at a faster pace, while manyexpanded into strategies in which they had little or no domain expertise.

The buyout industry has also experienced explosive growth. The industry’s AUMincreased by a similar magnitude from $113 billion in 1996 to over $600 billion in2006.3 In fact, the rapid growth of the industry did not abate until the onset of the2008 credit crisis. With cheap and readily available credit, buyout funds not onlygrew larger in size, they also leveraged their portfolio companies to unprecedentedlevels. The average debt-to-EBITDA (earnings before interest, taxes, depreciation andamortisation) ratio peaked at 6.2x in 2007.4 This growth in leverage was reversed twice

1 BCG & IESE Business School. (February 2008). The Advantage of Persistence.2 Thomson Reuters. Invested vs. Uninvested Capital and Cash-Flow Summary Reports, venture only, as atDecember 31, 2010.3 Thomson Reuters. Invested vs. Uninvested Capital and Cash-Flow Summary Reports, buyouts and otherprivate equity only, as at December 31, 2010.4 S&P Leverage Lending Review 4 Q10. (2010). Large-Cap buyouts are companies with EBITDA >$50m.

Transformationof the PEindustry

demands newapproach

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2006

2002

2007

2003

2008

2004

2009

2005

2010

Years

$billion

0

50

200

150

100

Source: Thomson Reuters. Invested vs. Uninvested Capital and Cash-Flow Summary Reports, ventureonly, as of December 31, 2010.

Figure 5.1: us venture capital industry – assets under management


63

7 Co-investments in funds of funds andseparate accountsBy Brian Gallagher, Twin Bridge Capital Partners

Co-investing in private equity has been around for years, but it has only recently becomea truly mainstream form of investing. There are many reasons for this evolution. Mostimportantly, investors have come to realise that there are significant quantitative andqualitative benefits to co-investing. General partners (GP) have also learned that co-investing has numerous benefits for their investment programmes. The mutual benefitsthat can be achieved through co-investing are well recognised.As a result, limited partners(LP) are, in increasing numbers, formalising co-investment programmes.

Co-investing can be carried out in all areas of alternative investments including hedgefunds, venture capital, mezzanine and buyout investments. Equity co-investment in buyoutdeals is the largest and most recognised segment and the focus of this discussion. Theconcepts and examples illustrated here, however, can be applied to any type of co-investment regardless of whether the co-investments are done through a fund of fundsvehicle or an institutional separate account.

Co-investment has been around for nearly as long as the buyout industry itself. Thepractice became more prevalent during the mid-to-late 1990s as institutional investorssought additional ways to deploy capital and GPs began to see LPs as helpful inexecuting larger transactions. Initially, it was common for equity sponsors to chargea reduced carried interest on co-investments. As the co-investment industry matured,GPs began to view co-investment investors as true partners. Deals were increasinglydone with no management fee and no carried interest whereas today LPs generallyexpect, and often require, co-investments to be executed without a management feeand carried interest.

Co-investingisnowamainstreamandacceptedcomponentof today’sprivateequity industry.During fundraising, GPs are routinely asked by interested LPs to address the likelihood ofco-investment in their next fund. While some GPs look at co-investment as a requirementto entice certain LPs into a fund commitment, the practice has evolved into an importantpart of the business model for most equity sponsors, offering a wide range of benefits toboth the LP and the sponsor. It is important to note that while many LPs clamour for co-investment opportunities, a significant percentage of these LPs do not have the staffing orinfrastructure to respond to and commit to co-investment opportunities in a timely manner.LPs who effectively structure their organisations to execute on a co-investment programmefind themselves at a competitive advantage for access to these benefits.

Background

History of co-investment

Current state ofco-investment


63

7 Co-investments in funds of funds andseparate accountsBy Brian Gallagher, Twin Bridge Capital Partners

Co-investing in private equity has been around for years, but it has only recently becomea truly mainstream form of investing. There are many reasons for this evolution. Mostimportantly, investors have come to realise that there are significant quantitative andqualitative benefits to co-investing. General partners (GP) have also learned that co-investing has numerous benefits for their investment programmes. The mutual benefitsthat can be achieved through co-investing are well recognised.As a result, limited partners(LP) are, in increasing numbers, formalising co-investment programmes.

Co-investing can be carried out in all areas of alternative investments including hedgefunds, venture capital, mezzanine and buyout investments. Equity co-investment in buyoutdeals is the largest and most recognised segment and the focus of this discussion. Theconcepts and examples illustrated here, however, can be applied to any type of co-investment regardless of whether the co-investments are done through a fund of fundsvehicle or an institutional separate account.

Co-investment has been around for nearly as long as the buyout industry itself. Thepractice became more prevalent during the mid-to-late 1990s as institutional investorssought additional ways to deploy capital and GPs began to see LPs as helpful inexecuting larger transactions. Initially, it was common for equity sponsors to chargea reduced carried interest on co-investments. As the co-investment industry matured,GPs began to view co-investment investors as true partners. Deals were increasinglydone with no management fee and no carried interest whereas today LPs generallyexpect, and often require, co-investments to be executed without a management feeand carried interest.

Co-investingisnowamainstreamandacceptedcomponentof today’sprivateequity industry.During fundraising, GPs are routinely asked by interested LPs to address the likelihood ofco-investment in their next fund. While some GPs look at co-investment as a requirementto entice certain LPs into a fund commitment, the practice has evolved into an importantpart of the business model for most equity sponsors, offering a wide range of benefits toboth the LP and the sponsor. It is important to note that while many LPs clamour for co-investment opportunities, a significant percentage of these LPs do not have the staffing orinfrastructure to respond to and commit to co-investment opportunities in a timely manner.LPs who effectively structure their organisations to execute on a co-investment programmefind themselves at a competitive advantage for access to these benefits.

Background

History of co-investment

Current state ofco-investment


64


Substantial quantitative benefits accrue to co-investing LPs. These benefits are attributableto the positive cash-flow characteristics associated with today’s co-investment deals,including improved net return and accelerated capital deployment. Since co-investing isdone either free of a management fee and carried interest, or at substantially reducedrates, the LP will, by definition, improve its net investment returns relative to a programmethat invests exclusively in funds.

The improvement in net returns for an active co-investor can be as much as 300 basis pointsor more as compared to a standard fund investing programme. By actively co-investing, anLP can deploy capital with quality sponsors at an accelerated rate,which reduces the J-Curveeffect associated with its private equity investing. A thoughtful and well-constructed co-investment portfolio can also allow the institutional investor to diversify further its portfolioand increase exposure to sectors that the co-investor prefers.

For many active co-investing LPs, co-investments typically comprise 25 percent or moreof their overall private equity exposure. Clearly, the quantitative benefits experienced bythe LP depend on the size of its co-investment portfolio. Figure 7.1 highlights the primaryquantitative benefits associated with a significant co-investment programme.

In addition to the superior quantitative benefits for an LP, the qualitative characteristicsassociated with co-investing yield ongoing returns to the relationship between the LPand the equity sponsor. Co-investments allow the investor to develop close relationshipswith senior equity sponsor professionals. This allows the investor to obtain a first-hand

Benefits to the LPQuantitative

benefits

Qualitative benefits

Year

1

Year

2

Year

3

Year

4

Year

5

Year

6

Year

7

Year

8

Year

9

Year

10

Year

11

Year

12

Year

13

Year

14

Years

Funds of fundsFunds of funds with co-investment

US$

millions

-80

-60

-40

-20

0

20

40

60

80

100

120

Source: Twin Bridge Capital Partners.

Figure 7.1: sample net cash-flow by year – traditional funds of funds versus funds offunds with co-investment


64


Substantial quantitative benefits accrue to co-investing LPs. These benefits are attributableto the positive cash-flow characteristics associated with today’s co-investment deals,including improved net return and accelerated capital deployment. Since co-investing isdone either free of a management fee and carried interest, or at substantially reducedrates, the LP will, by definition, improve its net investment returns relative to a programmethat invests exclusively in funds.

The improvement in net returns for an active co-investor can be as much as 300 basis pointsor more as compared to a standard fund investing programme. By actively co-investing, anLP can deploy capital with quality sponsors at an accelerated rate,which reduces the J-Curveeffect associated with its private equity investing. A thoughtful and well-constructed co-investment portfolio can also allow the institutional investor to diversify further its portfolioand increase exposure to sectors that the co-investor prefers.

For many active co-investing LPs, co-investments typically comprise 25 percent or moreof their overall private equity exposure. Clearly, the quantitative benefits experienced bythe LP depend on the size of its co-investment portfolio. Figure 7.1 highlights the primaryquantitative benefits associated with a significant co-investment programme.

In addition to the superior quantitative benefits for an LP, the qualitative characteristicsassociated with co-investing yield ongoing returns to the relationship between the LPand the equity sponsor. Co-investments allow the investor to develop close relationshipswith senior equity sponsor professionals. This allows the investor to obtain a first-hand

Benefits to the LPQuantitative

benefits

Qualitative benefits

Year

1

Year

2

Year

3

Year

4

Year

5

Year

6

Year

7

Year

8

Year

9

Year

10

Year

11

Year

12

Year

13

Year

14

Years

Funds of fundsFunds of funds with co-investment

US$

millions

-80

-60

-40

-20

0

20

40

60

80

100

120

Source: Twin Bridge Capital Partners.

Figure 7.1: sample net cash-flow by year – traditional funds of funds versus funds offunds with co-investment


105

Current trends in the fund of fundsmarket: A survey of practitionersBy Kelly DePonte, Probitas Partners

Historically, funds of funds have offered convenient access to the private equity market,typically for smaller or more inexperienced investors wanting to observe the privateequity market before developing their own investment programmes. The definingcharacteristics of funds of funds – diversification and access – are therefore aligned withthe multi-faceted purposes of a range of players with different investment needs.

Generalised diversification is no longer the name of the game as niche funds of fundshave emerged to challenge the larger, established fund of funds managers. They arealso tailoring programmes tomore specific investor interests. Thesemore targeted, nichefunds of funds have cropped up in conjunction with increased separate account activity.Although it is impossible to adequately track the amount of funds being diverted fromfunds of funds to separate accounts and to measure a substitution effect, the importantpoint to note is that the audiences for niche funds of funds and separate accounts aresubstantially different – in terms of overall size, interest, and experience of the investor.While fund of funds managers with deep know-how and broad-based relationships mayfind it relatively easy to address both funds of funds and separate accounts through theirintermediary role, focused separate accounts do pose challenges for them – for examplewhen dealing with limited investment opportunities, time, or simply differences in scale.

This new trend of specialised funds of funds is easily illustrated by the wide rangeof targeted investment mandates of the funds of funds currently in market, includingdistressed, Asia, emerging markets, Latin America, emerging Europe, venture capital,and debt.

In order to understand better how fund of funds managers perceive the market and theissues that are important to them,we conducted an online survey of practitioners duringthe first half of October, 2011.

In order to put the responses to the survey in proper context, the first few questions aredesigned to build a profile of the respondents.

Over 35 survey responses were received – 75 percent of the respondents are fromorganisations headquartered in Western Europe or North America, the two mostdeveloped private equity markets. However, there is also a significant number ofresponses frommore emerging markets, led by Asia, a market where a number of fundsof funds have been launched over the last five to six years (see Figure 1).

Profile ofrespondents


105

Current trends in the fund of fundsmarket: A survey of practitionersBy Kelly DePonte, Probitas Partners

Historically, funds of funds have offered convenient access to the private equity market,typically for smaller or more inexperienced investors wanting to observe the privateequity market before developing their own investment programmes. The definingcharacteristics of funds of funds – diversification and access – are therefore aligned withthe multi-faceted purposes of a range of players with different investment needs.

Generalised diversification is no longer the name of the game as niche funds of fundshave emerged to challenge the larger, established fund of funds managers. They arealso tailoring programmes tomore specific investor interests. Thesemore targeted, nichefunds of funds have cropped up in conjunction with increased separate account activity.Although it is impossible to adequately track the amount of funds being diverted fromfunds of funds to separate accounts and to measure a substitution effect, the importantpoint to note is that the audiences for niche funds of funds and separate accounts aresubstantially different – in terms of overall size, interest, and experience of the investor.While fund of funds managers with deep know-how and broad-based relationships mayfind it relatively easy to address both funds of funds and separate accounts through theirintermediary role, focused separate accounts do pose challenges for them – for examplewhen dealing with limited investment opportunities, time, or simply differences in scale.

This new trend of specialised funds of funds is easily illustrated by the wide rangeof targeted investment mandates of the funds of funds currently in market, includingdistressed, Asia, emerging markets, Latin America, emerging Europe, venture capital,and debt.

In order to understand better how fund of funds managers perceive the market and theissues that are important to them,we conducted an online survey of practitioners duringthe first half of October, 2011.

In order to put the responses to the survey in proper context, the first few questions aredesigned to build a profile of the respondents.

Over 35 survey responses were received – 75 percent of the respondents are fromorganisations headquartered in Western Europe or North America, the two mostdeveloped private equity markets. However, there is also a significant number ofresponses frommore emerging markets, led by Asia, a market where a number of fundsof funds have been launched over the last five to six years (see Figure 1).

Profile ofrespondents


106

section ii: The survey

Most of the survey respondents are from well-established managers – nearly two-thirdshave been active in the market for ten years or more. There are no responses from newmanagers (that is, those that have only been active for two years or less), but in thedifficult fundraising environment that has existed since the great financial crisis, relativelyfew new groups have been established (see Figure 2).

Figure 3 highlights the different types of strategies offered by respondent firms. Itis obvious from a quick review of the percentages in the strategies that a number offirms provide funds of funds with different strategies while many of these firms provide

Figure 1: Location of firms’ headquarters

Western Europe51.4%

Australia5.7%

Middle East2.9%

North America25.7%

Asia14.3%

Figure 2: number of years active in private equity investing

*Less than 2 years 0%

Between5 years and 10 years25.0%

Between 2 years and 5 years11.1%

More than 15 years27.8%

Between10 years and 15 years

36.1%


106

section ii: The survey

Most of the survey respondents are from well-established managers – nearly two-thirdshave been active in the market for ten years or more. There are no responses from newmanagers (that is, those that have only been active for two years or less), but in thedifficult fundraising environment that has existed since the great financial crisis, relativelyfew new groups have been established (see Figure 2).

Figure 3 highlights the different types of strategies offered by respondent firms. Itis obvious from a quick review of the percentages in the strategies that a number offirms provide funds of funds with different strategies while many of these firms provide

Figure 1: Location of firms’ headquarters

Western Europe51.4%

Australia5.7%

Middle East2.9%

North America25.7%

Asia14.3%

Figure 2: number of years active in private equity investing

*Less than 2 years 0%

Between5 years and 10 years25.0%

Between 2 years and 5 years11.1%

More than 15 years27.8%

Between10 years and 15 years

36.1%


121

123 Venture

41 boulevard desCapucinesParisF-75002France

Tel: 33 1 4926 9800www.123venture.com/[email protected]

Assets undermanagement:€375 million

123 Venture provides advisory, consulting and fund of fundsservices mainly to private clients and family offices, but also toinstitutional clients. It manages several funds of funds including:123 Explorer (a diversified European fund of funds established in2001), 123 Expansion funds, 123 Multinova funds and ‘white label’funds for Private Banks.

Year first invested inprivate equity: 2001

Approx number offunds committed to: 15

ContactsMr. Eric [email protected]

Mr. Olivier GoyFounder andChief Executive [email protected]

Regional allocation Fund type allocationNorth America Gereralist

Western Europe Buyout/later-stage

Central & Eastern Europe Mid-marketMiddle East / Africa Venture

Asia Pacific Mezzanine/subordinateddebtLatin America Turnaround/distressed

SecondariesInfrastructureOther

investment opportunitiesSecondary directs First-time fundsDirects Shariah-compliant fundsCo-invests Sec’dry sale of commitments

57 Stars

616 H Street N.W.Suite 450Washington DC20001United States of America

Tel: 1 202 824 [email protected]

Assets undermanagement:$1 billion

57 Stars is an asset management firm focusing on private equityinvestments in emerging markets. The firm manages a couple ofcaptive fund of funds vehicles for the New York State CommonRetirement Fund (NYSCRF) and the California Public Employees’Retirement System (CalPERS). In September 2011, the firm’snew Latin American focused fund of funds, the 57 Stars LatinAmerican Opportunity Fund, announced its first investment. Thefund committed capital to Pátria Investimento’s P2 Brasil PrivateInfrastructure Fund II, which invests in Brazilian infrastructure projects.


Approx number offunds committed to:

ContactsMr. Steve CowanManagingDirectorWashingtonDCTel: 1 202 629 [email protected]

Mr. BernardMcGuire, [email protected]

Regional allocation Fund type allocationNorth America GereralistWestern Europe Buyout/later-stage


Asia Pacific Mezzanine/subordinateddebt

Latin America Turnaround/distressed



A comprehensive directory of fund of funds practitioners and advisers


121

123 Venture

41 boulevard desCapucinesParisF-75002France

Tel: 33 1 4926 9800www.123venture.com/[email protected]

Assets undermanagement:€375 million

123 Venture provides advisory, consulting and fund of fundsservices mainly to private clients and family offices, but also toinstitutional clients. It manages several funds of funds including:123 Explorer (a diversified European fund of funds established in2001), 123 Expansion funds, 123 Multinova funds and ‘white label’funds for Private Banks.



ContactsMr. Eric [email protected]

Mr. Olivier GoyFounder andChief Executive [email protected]







57 Stars

616 H Street N.W.Suite 450Washington DC20001United States of America



57 Stars is an asset management firm focusing on private equityinvestments in emerging markets. The firm manages a couple ofcaptive fund of funds vehicles for the New York State CommonRetirement Fund (NYSCRF) and the California Public Employees’Retirement System (CalPERS). In September 2011, the firm’snew Latin American focused fund of funds, the 57 Stars LatinAmerican Opportunity Fund, announced its first investment. Thefund committed capital to Pátria Investimento’s P2 Brasil PrivateInfrastructure Fund II, which invests in Brazilian infrastructure projects.



ContactsMr. Steve CowanManagingDirectorWashingtonDCTel: 1 202 629 [email protected]

Mr. BernardMcGuire, [email protected]



Asia Pacific Mezzanine/subordinateddebt

Latin America Turnaround/distressed



A comprehensive directory of fund of funds practitioners and advisers


122

section iV: The directory

747 Capital747 Third Avenue22nd FloorNew YorkNY10017United States of America


Assets undermanagement:$130 million

747 Capital is a New York-based fund of funds manager focusedon the small-cap end of the US private equity market. The firm wasestablished in 2001. 747 Capital provides family offices and otherinstitutional investors with diversified access to top tier US small-cap private equity funds, secondaries, and direct co-investmentsthrough the firm’s funds of funds, separate accounts, and LP-specific mandates.



ContactsMr.Gijs F. J. van ThielManaging [email protected]

Mr. Marc J. M. derKinderenManaging PartnerNew [email protected]



Central & Eastern Europe Mid-marketMiddle East / Africa VentureAsia Pacific Mezzanine/subordinateddebtLatin America Turnaround/distressed

Secondaries

InfrastructureOther

investment opportunitiesSecondary directs First-time funds

Directs Shariah-compliant fundsCo-invests Sec’dry sale of commitments

Abbott Capital Management1211 Avenue of theAmericasSuite 4300New YorkNY10036-8701United States of America



Abbott Capital Management (ACM) is an independent investmentadviser focused exclusively on private equity. It operates mainly as afund of funds manager, predominantly investing in US andWesternEuropean vehicles. In addition to its fund of funds products, AbbottCapital Management offers separate account management servicesin select cases. Abbott Capital is focused exclusively on investing inprivate equity funds including venture capital, buyouts and specialsituations funds, and making investments in professionally managedpartnerships. Abbott manages 6 funds of funds vehicles.

Year first invested inprivate equity:


ContactsMr. Charles H. van HorneManaging DirectorMarketing and ClientServicesNew [email protected]







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section iV: The directory

747 Capital747 Third Avenue22nd FloorNew YorkNY10017United States of America


Assets undermanagement:$130 million

747 Capital is a New York-based fund of funds manager focusedon the small-cap end of the US private equity market. The firm wasestablished in 2001. 747 Capital provides family offices and otherinstitutional investors with diversified access to top tier US small-cap private equity funds, secondaries, and direct co-investmentsthrough the firm’s funds of funds, separate accounts, and LP-specific mandates.



ContactsMr.Gijs F. J. van ThielManaging [email protected]

Mr. Marc J. M. derKinderenManaging PartnerNew [email protected]



Central & Eastern Europe Mid-marketMiddle East / Africa VentureAsia Pacific Mezzanine/subordinateddebtLatin America Turnaround/distressed

Secondaries

InfrastructureOther

investment opportunitiesSecondary directs First-time funds

Directs Shariah-compliant fundsCo-invests Sec’dry sale of commitments

Abbott Capital Management1211 Avenue of theAmericasSuite 4300New YorkNY10036-8701United States of America



Abbott Capital Management (ACM) is an independent investmentadviser focused exclusively on private equity. It operates mainly as afund of funds manager, predominantly investing in US andWesternEuropean vehicles. In addition to its fund of funds products, AbbottCapital Management offers separate account management servicesin select cases. Abbott Capital is focused exclusively on investing inprivate equity funds including venture capital, buyouts and specialsituations funds, and making investments in professionally managedpartnerships. Abbott manages 6 funds of funds vehicles.

Year first invested inprivate equity:


ContactsMr. Charles H. van HorneManaging DirectorMarketing and ClientServicesNew [email protected]







fun of funds

Documents

new funds

editor ixintroduction

editor xisection

helen lewerproduction

written permission

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reasonable effort